Consistent with the current macroeconomic trends, railroads started the year on a mixed note. Going by the rail traffic report for the first quarter 2013, growth in automotive and petroleum products’ shipments was steady while coal and grain shipments continued to cast a shadow over the rail freight industry.

According to the Association of American Railroads’ (:AAR) rail traffic report, cumulative performance of the North American railroads (including U.S., Canadian and Mexican railroads) have fallen 1.5% year over year in the first quarter of the year. The biggest contributor to this decline was grain, which dropped 11%. Coal volumes followed closely, falling around 7%.

Going by the quarterly performance of the class 1 railroad, we see continued lower volumes from most of these carriers. One of the largest class 1 railroads in North America -- Union Pacific Corp. (UNP) -- registered first quarter volume decline of 2% year over year. Another major railroad CSX Corp. (CSX) also reported a similar level of decline in its volumes. Going forward, Canadian counterpart, Canadian Pacific Railway Ltd. (CP) also experienced lackluster growth trend with flat volume growth on a year-over-year basis.

Notably, despite mixed carload results, these carriers have mostly generated positive earnings in the reported quarter. The primary catalyst to this bottom-line performance was operational efficiency even in times of low market demand. Rising employee productivity, deploying fuel-efficient locomotives and undertaking railroad safety measures are some of the key drivers of profitability even in adverse market conditions.

Rail carriers like Canadian Pacific recorded operating ratio improvement of 430 basis points year over year. Continued focus on maintaining asset efficiencies, safety measures and increased productivity have been the prime contributors to Canadian Pacific’s success in the first quarter. There are several other near-term growth catalysts in the railroad industry.

Rising Contribution of Petroleum Product Shipment

According to the AAR report, rail traffic from petroleum products has seen a whopping 46% growth in the three-month period ended Mar 30. According to the Energy Information Administration’s (EIA) reports, U.S. crude oil exceeded 7 million barrels per day production, representing record growth since the last two decades. Further, in 2013, long-term projections of EIA suggest that this growth may also go up to 10 million barrels per day over a period of 2020 to 2040.

As a result, this surge represents a potential opportunity for revenue accretion, which the railroads are trying to tap with infrastructural development. According to industry sources, the role of crude oil as a revenue contributor has grown by leaps and bounds in a four-year span from a mere 3% to 30% of the oil and petroleum products shipment by railroads.

Despite the fact that rail-based crude transportation costs five times more ($10–$15 per barrel), crude shippers are compelled to rely on rail-based transport. This is due to the lack of pipeline infrastructural support in key oil and gas fields like Bakken Shale Formation in North Dakota and Montana, Eagle Ford Shale, Barnett Shale and Permian basin in Texas, the Gulf of Mexico and Alberta oil sand fields in Canada.

In 2012, Canadian National Railway, which operates along the Western Canada (Alberta region) to the Gulf Coast, has shipped approximately 30,000 tank cars of volumes of crude oil, while its counterpart Canadian Pacific shipped 53,000 tank cars of crude during the same period. Another giant railroader, BNSF Railroad of Berkshire Hathaway Inc. (BRK-B), which serves the North Dakota region reportedly earned $272 million from crude shipments last year by shipping approximately 100 million barrels of oil.

In the coming days, we expect railroads to accelerate their investment in order to create adequate service capacity for the oil and gas markets. Canadian Pacific projects crude shipment to reach up to 70,000 oil-tank cars by the year-end and move to 140,000 by the end of 2015. This kind of exponential growth in crude oil shipments is taking place across the rail industry. Consequently, we expect petroleum shipments to remain favorable and emerge as a significant revenue contributor in the long term.

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